Strong financial position to help UAE steer clear of recession

By

Nadim Kawach

PublishedMonday, February 23, 2009

The collapse in oil prices will ally with lower crude output to depress the UAE economy and revenues but its strong financial position will prevent the country from sliding into a recession, a key Saudi bank said yesterday.

After making big leaps in the past few years, the UAE's gross domestic product is expected to contract in nominal terms and grow by less than one per cent in real terms, the Saudi American Bank (Samba) Group said in a 22-page research.

Its fiscal situation will also be a victim of lower crude prices and production but the balance is expected to remain in surplus and could only revert to a deficit if oil prices dip below $40 through the year, Samba said.

Although the UAE's foreign assets could have suffered from the global financial distress, they remain large enough to cushion any adverse impact. The study also expected inflation in the UAE to dive to around four per cent this year after surging to a record high of nearly 14 per cent in 2008.

CHALLENGING OUTLOOK

"The outlook for 2009 is challenging, particularly for banks, real estate, tourism and project financing. Real GDP growth will fall steeply. Even official statements suggest 'low single digits…' efforts at providing a fiscal stimulus – projected spending in the 2009 Federal and Dubai Government budgets is up 21 and 42 per cent respectively – and liquidity support to banks will certainly help, but inevitably lower credit growth as banks undergo a period of deleveraging will curtail broader economic activity," the study said.

"Many of the UAE's large-scale projects are likely to be postponed or cancelled, particularly in the real estate sector where reports suggest up to $260 billion (Dh955bn) worth of projects have already suffered such a fate. In addition, oil output is projected to drop by 12 per cent in line with new Opec policies to curb production.

"Overall real GDP growth is expected to slow sharply to less than one per cent this year. Although prospects are challenging, the UAE is well equipped to weather the global downturn."

FISCAL SURPLUS

The study said despite lower oil prices and output, the fiscal balances are expected to remain in surplus providing welcome financial ballast. "In addition, the UAE has large foreign assets to draw on, although it is clear that these too will have suffered from the collapse in asset prices worldwide," it said.

"As importantly, the authorities have been quick to respond to the evolving liquidity crunch and have moved to inject liquidity into the banking system and take steps to fill the emerging funding gap given the reduced access to international capital markets. Together with fiscal stimulus packages this should prevent the economy from slipping into outright recession."

Turning to 2008, it said surging oil and gas revenues ensured the fiscal and external positions remained in large surplus through the year. It cited data by the Washington-based Institute of International Finance (IIF) as showing the UAE's fiscal surplus is estimated to have leaped to 30 per cent of GDP, while the current account surplus is estimated at around 23 per cent.

Hydrocarbon exports soared to an all-time high of around $124bn, while non-hydrocarbon exports performed strongly as well, it said.

LOW OIL EXPORTS

"The outlook for 2009 is considerably less rosy with lower oil prices and output likely to result in halving of hydrocarbon exports to around $60bn, while non-hydrocarbon exports will struggle in the face of the global recession… however, with import prices and volumes also likely to dip, the current account is still expected to remain in surplus at around four per cent of GDP," Samba said.

"Similarly, despite additional spending from fiscal stimulus packages at the federal and emirate level, the consolidated fiscal balance is also projected to remain in surplus at just under five per cent of GDP. The fiscal accounts would, however, probably slip into deficit if average oil prices for the year stayed below the estimated breakeven budget oil price of $40." The study noted that large current account surpluses and strong inflows of foreign direct investment have led to a substantial build up in official foreign assets over the last two years, pushing official reserves up to $78bn in 2007.

But it added that despite rising oil revenues during the first half of 2008, reserve levels fell back to $41bn in September as speculative foreign inflows were reversed and access to external finance was sharply curtailed.

PUBLIC ASSETS

While the drop in official reserves is noteworthy, they represent only a small portion of the public sectors foreign assets, which are dominated by the Abu Dhabi Investment Authority (Adia), Samba said.

It estimated the total assets under Adia's management to range from $300bn to $865bn, believed to be 50 per cent invested in equities, 20 per cent fixed income, 10 per cent real estate, and 20 per cent in a mixture of cash, hedge funds and strategic investments.

"The unprecedented crisis in the world financial markets during 2008 will certainly have had an adverse impact on the value of these assets," it said.

"Such has been the poor performance of markets in 2008 that valuation declines are likely to have offset additions from sustained large fiscal and current account surpluses. However, even if we take the lower estimates of $335bn in assets at end-2007, the level of Adia's assets at the end of 2008 is still likely to be close to $300bn, taking account additions and probable losses."

CREDITOR POSITION

The study said such massive assets have allowed the UAE to retain its large net external creditor position despite a sharp rise in borrowing. Available estimates put the UAE's total external debt at around $150bn at end-2008, equivalent to 55 per cent of GDP.

Using conservative estimates of the UAE's total foreign assets of $405bn (official reserves plus bank foreign assets plus estimated Adia's assets); this gives a positive net external asset position of $255bn, equivalent to 93 per cent of GDP," it said.

"Of course the position could be considerably larger depending on the true level of Adia's assets. Whatever the real figure, it is clear the UAE has considerable assets to cushion the economy from the global recession."

INFLATION

As for inflation, Samba forecast a sharp decline in the rate because of the stronger US dollar, falling world commodity prices and weaker domestic demand.

It estimated inflation in the UAE at a record high of 14 per cent last year compared to nearly 11 per cent in 2007.

But it said such levels are believed to be underestimated as real rates could be close to 20 per cent in 2008 on the grounds they are based on prices paid by UAE nationals who benefit from extensive subsidies and rent controls not available to the majority expatriate population.

"Despite still loose monetary policies, interbank rates remain elevated and banks have also started to raise rates paid on deposits. These increases will be passed on to borrowers, and this is likely to add further impetus to the expected slowdown in credit growth and thus ease inflationary pressures," it said.

"Additional factors that should prompt a slowing in inflation in 2009 include a relative strengthening of the US dollar, falling international commodity prices, an easing of supply bottlenecks and capacity constraints as projects are completed, cancelled or postponed, and lower rents. Overall inflation in the UAE is projected to slow to around four per cent in 2009."